Tuesday, 21 May 2013

Half a billion at Christie's - what does it mean? Probably nothing.

Picture: Christie's

There's been a lot of pontificating after the Christie's Post-War and Contemporary Art sale on May 15 made $495,021,500 (including premium). Sixty five lots were sold. That's not a lot of data points compared to the millions or trillions of transactions making up other data series, like stock market indices or GDP. The background to recent record prices is that there are a lot of billionaires in the world, and a couple of billionaires competing for a fashionable 'trophy' work of art can push the price into the stratosphere. At those rarefied heights fashions change quickly and should be understood with reference to 'Hello' magazine rather than the Burlington.

Some people have made a link to quantitative easing ('QE'), but I'm not so sure. QE involves the central bank buying bonds in the market. The effective is to increase the money supply, because the central bank is effectively printing new money that is released into the economy in return for the bonds they buy. That increases inflation in the economy, because it means that (all things being equal) there is more money chasing the same goods and services. It's reasonable to assume that art prices will creep up in line with everything else.

But the stronger claim is that QE encourages art prices higher because it makes bonds unattractive investments. Bond prices go up, which is good if you already own them. But it means that new buyers are getting a worse return, because the effect of bond prices going is that the interest rate received by the investor (the 'yield') goes down. If a $1m dollar bond paying $100k annual interest rises in price to $2m, then the yield has fallen from 10% to 5%. The argument is that wealthy bond investors are putting their money into art as an alternative investment.

I have a few problems with that claim. First, I suspect that the uber-rich are disproportionately invested in equities (shares) rather than bonds. QE is somewhat favourable to equities, partly because they are an inflation hedge, and partly because of the more generally positive effects of QE on the growth outlook. Second, QE typically involves buying government bonds. Riskier corporate bonds may still be attractive, partly because QE is positive for growth and inflation, meaning that the risk of corporate defaults across the economy may be slightly lower with QE than without.

Turning to the positive case for investing in art, I'm even more sceptical Art as an asset class is inherently speculative, because art produces no income stream. Property, bonds and equities can be valued based on the cashflows that they generate. Art gives pleasure to the owner, but you can only guess how much some one might pay in future for the pleasure of ownership. You cannot rationally account for high art prices as an outcome of asset allocation decisions. You can rationally allocate investment funds between equities, bonds and property, but art is a different category.

The extraordinarily high transaction costs associated with art (measured in tens of percentage points for art rather than hundredths of a percentage point for financial assets) means that it's not even a sensible inflation hedge, except over extremely long time horizons - meaning generations rather than decades. And each work of art is unique, meaning that the price is uncertain and volatile relative to any index you can devise. Precious metals are a better hedge, or even gemstones if you think gold is over-valued.

Prices of top-level artworks reflect spending decisions by a relatively small group of squillionaires. We should be cautious of generalising too much from their behaviour. It's possible that it reflects more limited investment opportunities, meaning that the rich are consuming more and investing less. But it could just be that a lot of the new rich from emerging economies are getting to the stage in their lives where they want to enjoy their wealth - and inexplicably some people get more enjoyment from Basquiat than from Rembrandt.

A new record total for an auction is a headline without a story. It's tempting to create narratives, but it really doesn't mean very much.

4 comments:

As usual, a very interesting and informative analysis. Which way do you think the market is heading? Ben Lewis had been predicting that the bubble would burst since 2007. But each time the contemporary art market took a turn for the worst it then recovered again with stubborn tenacity...

Thanks! I'm nervous about making predictions, because I always get it wrong. I think there's a lot of potential for the market as a whole to stay at a high level because there are so many people for whom $10m or even $100m isn't a big deal. High prices in the nineteenth century were sustained with relatively far fewer rich people. On the other hand, I think some of the current celebrity artists will fall from fashion, and maybe big crashes in a couple of famous names will dent the whole market as people focus more on the downside. I think the market pessimists are focusing too much on art as investment and not paying enough attention to art as luxury consumption - but that doesn't mean their predictions will be wrong.